Appetite grows for high-yield emerging market debt

The growing appetite for emerging-market bonds is expected to increase over the next few years as global pension funds look for new high-yield ways to satisfy their long-run funding commitments, reports Pyramis Global Advisors, the institutional arm of Fidelity Investments.

“Some of the traditional approaches to asset allocation are starting to change,” said Karthik Ramanathan, senior vice-president and director of bonds for Fidelity’s fixed-income division. “When we review the overall data, one thing that came out clear was the move and exposure to more global bond strategies, particularly in emerging markets.”

Pyramis this summer polled 632 institutional investors in 16 countries — including 92 pension plans in Canada — whose collective assets under management represented more than US$5-trillion, or roughly 20% of the total global pension market.

The second wave of results, released Thursday, said 24% of global investors will increase allocations to emerging-market debt over the next few years, but just 15% of Canadian institutional investors said they would follow suit.

Mr. Ramanathan said Canadian pension plans will continue to increase exposure to EM debt despite home-bias tendencies associated, at least in part, with currency risk.

“There has been less appetite for non-Canadian fixed income because of the currency exposure,” he said. “Typically, there has been a passive stance on currency hedging, but many countries including Canada are now looking at currency as an alpha source.”

The biggest proponents of emerging-market debt are in Europe, where 36% of respondents plan to increase exposure to hard currency EM debt, while 47% plan to allocate more to local currency issues.

In Asia, 37% of institutional investors said they plan to increase allocations to hard currency or U.S. dollar-denominated EM debt, and 33% said they will likely increase exposure to local currency EM debt.

North American pension funds are less enthusiastic. Just 13% of U.S. institutional investors plan to increase allocations to local currency EM debt while 13% will likely increase exposure to hard currency EM debt.

Mr. Ramanathan said the bullish demand for such debt overall is because emerging-market currencies have appreciated relative to the U.S. dollar over the past 10 years, and inflationary pressure in these countries has been relatively low.

Central banks in emerging markets have also done a solid job building credibility by adopting greater fiscal discipline than in the past.

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